The Stock Market Gets Big News From the Federal Reserve Today (March 19)

The Federal Reserve is charged with maintaining maximum employment and stable prices. To balance both goals, the U.S. central bank shapes monetary policy by adjusting the target range on a benchmark interest rate, known as the federal funds rate.

Policymakers have reduced the benchmark rate 100 basis points since the cutting cycle began in September, but chose to pause cuts in January. The market expects that pause to continue at the March meeting, which ends today (March 19). Even so, investors are eagerly awaiting commentary.

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Policymakers will publish updated economic projections this afternoon, providing insight into the potential consequences of tariffs imposed by the Trump administration. The S&P 500 (SNPINDEX: ^GSPC) is currently 9% below its record high, but the stock market may continue falling if the Fed's outlook disappoints.

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Tariffs imposed by the Trump administration threaten to boost inflation and weaken economic growth

President Donald Trump has brought about a sudden, dramatic shift in U.S. trade policy since returning to the White House. His administration has imposed tariffs on imports from China, Canada, and Europe, as well as steel and aluminum. Also, Trump has threatened to hit European goods with tariffs, and he plans to impose reciprocal tariffs in April.

David Kelly, chief global strategist at JPMorgan Chase, recently enumerated the risks, saying, "The trouble with tariffs, to be succinct, is that they raise prices, slow economic growth, cut profits, increase unemployment, worsen inequality, diminish productivity, and increase global tensions."

Indeed, the nonpartisan Tax Foundation estimates tariffs imposed to date will reduce U.S. gross domestic product (GDP) by 0.4 percentage points. And adding tariffs on European goods would further reduce GDP by 0.3 percentage points. Those estimates do not account for retaliatory actions taken by other countries, nor do they include the impact of reciprocal tariffs.

Meanwhile, the U.S. economy is showing signs of strain. Consumer spending in January fell for the first time in two years. And consumer sentiment in March tumbled to its lowest level since November 2022.

Also, data from the Federal Reserve Bank of Atlanta shows U.S. GDP is on pace to decline 1.8% in the first quarter. That would be the sharpest contraction since the early days of the COVID-19 pandemic nearly five years ago.

The stock market could rise or fall sharply, based on the Federal Reserve's updated economic projections

As mentioned, the market does not expect a rate cut at the March meeting. But this meeting could still have a material impact on the stock market because the Federal Reserve will update its economic projections. That will provide insight into the potential consequences of tariffs imposed by the Trump administration.

Unfortunately, the market may interpret the updated projections as worrisome regardless of the actual data. That's because tariffs threaten to simultaneously increase inflation and weaken economic growth, a condition known as stagflation. Those forces usually move in the same direction; high inflation usually follows strong economic growth. But if they move in opposite directions, it would effectively tie the hands of the Federal Reserve.

To elaborate, policymakers could normally lower their benchmark interest rate to stimulate the economy, but doing so would also make inflation worse. Similarly, policymakers could normally raise their benchmark rate to curb inflation, but doing so would also slow economic growth. In short, stagflation is dangerous because the Federal Reserve is limited in its ability to correct the problem.

Consequently, any sign that policymakers expect stagflation to become an issue would likely send the stock market lower. Alternatively, any sign that policymakers view the tariffs imposed by the Trump administration as a temporary headwind could reassure investors and send the stock market higher.

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